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Some Perspectives On A Potential Kioxia/WDC NAND Merger

Recently there have been rumors in the press of a possible merger of Kioxia and Western Digital’s NAND flash and SSD division. Western Digital may have sought a potential buyout of what had been Toshiba Memory (since renamed Kioxia) when it was spun out from Toshiba to raise money to fund operations of the troubled parent company in 2018. More than likely Western Digital was leveraging its flash memory joint venture with Toshiba to get the best terms for its continued NAND flash and SSD business.

The recent speculation is driven by a settlement in June 2022 with activist investor Elliot Management saying that WDC would consider separating its hard disk drive and flash memory business. Since then, the company has considered whether creating separate businesses, selling the flash business or other options make sense. Recent rumors indicate that a decision on the future of WDC’s storage businesses will be made in the near future.

Let’s look at what the benefits and costs could be for WDC selling its flash memory business to Kioxia. First let’s look at the market share of the major NAND suppliers. According to Trendforce in Q3 2022 Samsung had 31.4% of the market followed by Kioxia with 20.6%, SK hynix and Solidigm (Intel’s former NAND business) at 18.5%, WDC at 12.6%, Micron at 12.3% and other companies at 4.6%. On its face, combining Kioxia and WDC’s NAND business would lead to the largest NAND manufacturer at 39.1%, but things never work out that way.

If Kioxia and WDC combined, it is likely that some customers would move some of their business from the new joint company to other vendors in order to reduce their dependence upon that company and to support its competitors. That certainly was the case when there were major mergers of HDD companies in the 2010’s. So, a combined Kioxia and WDC might not be the market leader, at least not for long.

Also, let’s look at WDC’s flash and HDD revenues and profits from their quarterly reports to see how the two WDC businesses compare to each other. The chart below shows the company’s NAND flash and HDD quarterly revenues from CQ1 2020 through CQ3 2022. From a revenue point of view the two businesses somewhat track with each other, with the HDD business usually generating the most revenue each quarter.

In the following chart we show the gross margin of WDC’s NAND flash and HDD business. WDC’s NAND gross margins generally exceed those of its HDD business. Gross margins should generally correlate with the businesses’ profitability. Note that the bit drop in HDD business margins in CQ2 2022 was due to a major correction in the company’s HDD business with continuing declines in the company’s legacy business after a boost during the pandemic and excess inventory in the nearline HDD business. We will talk about WDC’s NAND profitability again after talking about Kioxia’s financials over the last few years.

The following chart shows Kioxia’s sales and profit in Yen from their quarterly reports. Sales have been generally increasing from CQ1 2020 through CQ3 2022 but the company’s profit is far more dynamic. Kioxia and WDC get their NAND flash from the same fabs in Japan, why is there such a difference if the profitability of the two businesses?

Analyst Jim Handy of Objective Analysis wrote an article analyzing the profitability of WDCs NAND business and Kioxia’s business back in 2019. Jim points out that the business arrangement between WDC and Kioxia (then Toshiba Memory) allow WDC to take up to 50% of the output of the joint venture fab. However, they don’t have to take the full 50% of their share and they only have to pay Kioxia for the product they take from the joint venture fab. NAND flash fabs are very expensive to build and once built, it makes sense to manufacture as much product as the factory is capable of to get a return on the capital cost of the factory.

When demand is down for flash memory and the prices are declining this provides an advantage for WDC. The company can control potential losses by only taking as much production from the joint fab as they can sell, while Kioxia needs to try and sell their share plus what WDC doesn’t take. This causes additional price pressure for Kioxia. As a result of this agreement then WDC NAND business profitability tends to be more steady than Kioxia’s.

With this information, would it make sense for WDC to sell its NAND flash business to Kioxia? Kioxia would definitely gain, but WDC would lose a good source of revenue and profit. So,it would be surprising it WDC would do that. They could separate the two businesses as separate companies, as long as the new NAND business retained the product deal with Kioxia, but it doesn’t seem to make sense for WDC to sell its NAND business to Kioxia.

Looking at the fab arrangement between Kioxia and WDC and the history of NAND business profitability for the two companies a merger would be much more advantageous for Kioxia than WDC. This makes it difficult to believe that WDC would spin out this business to Kioxia, but time will tell.